How Investment Fees Eat Away At Your Wealth
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Do you know how much you are paying in investment fees each year?
Better yet, do you know how much you have paid in total since you first began investing?
I bet the answer to these questions is no.
This is a bad thing.
You need to know how much you are paying in fees if you want your money to grow.
Now some of you reading this might not think you pay any investing fees since you aren’t billed for them.
But you do pay fees. You just never receive a bill.
Pretty sneaky, right?
Others might not think that the fees they are paying have a significant impact on their investments.
While this can be true when you are first starting out, as your investments grow in value, the fees you pay do have a significant impact on your wealth.
This is why I am against Dave Ramsey’s investment strategy. He doesn’t teach his followers the effect fees have on their wealth, among other things.
In this post, I am going to walk you through the common investing fees you are paying and show you the impact they are having on your wealth.
By the end, you will be able to take action on your investments to ensure you are growing your money as quickly as you can and not paying outrageous fees.
What Are Investing Fees?
For the purposes of this post, when I say investment fees, I am talking about management fees on mutual funds and exchange traded funds (ETFs).
They also are called expense ratios when given in the form of a percent.
For example, the Vanguard Star fund (VGSTX) has an expense ratio of 0.31%.
What this means to you as an investor is that you are paying $3.10 for every $1,000 you have invested in this mutual fund.
So if you have $10,000 invested, you are paying $31 every year in fees for this fund.
Understand that this is per fund. If you are invested in 5 different mutual funds, each fund charges its own management fee.
To keep things simple, let’s say you have $10,000 invested in 5 different mutual funds (because diversification is good) and they all charge 0.31% in management fees.
This means every year you are paying $155 in fees.
I know these expenses don’t seem so bad.
Heck, your monthly cable bill is more expensive than the annual fund fee example I am talking about!
The catch is that Vanguard tends to be the leader in low cost investing.
This means they charge some of the lowest management fees in the industry.
According to the Investment Company Institute, the average equity mutual fund expense ratio in 2018 was 0.55%. The average bond fund expense ratio was 0.48%.
But averages can be misleading. A few outliers can skew the average. Because of this, I like to look at the median.
The median expense ratio for equity mutual funds was 1.16% and 0.81% for bonds funds, according to the Investment Company Institute.
And small cap or international mutual funds tend to be higher than this.
If you have $10,000 invested in a mutual fund with a management fee of 1.16%, that comes to $116 a year.
And if you have 5 mutual funds with $10,000 invested charging 1.16%, you are paying $580 a year in fees.
This amount of money might not sound like a like to you. But this is only part of the investment fee story.
Over Time, Investment Fees Add Up
To keep things simple, I’ll stick with the median investment fee of 1.16% and assume $10,000 is invested in 5 different funds.
While you are paying $580 in fees, remember this is annually. Over the course of investing for 25 years, this annual fee comes to a total of $14,500!
But there are still two more issues here that we need to look at to get the complete picture.
- Your investments will be growing in value over these 25 years.
- Opportunity cost plays a major role in “lost” money.
Let’s assume your investments grow at 8% annually for 25 years and you do not add any additional money to them.
After 25 years, your five $10,000 investments have grown in value to $255,789. The resulting management fee you paid comes to $38,210.
Now let’s look at opportunity cost.
What is opportunity cost?
This is the amount of money that if it was still invested in the fund, it could compound and grow into a larger amount.
Therefore, fees cost you twice. First as a fee you pay, and second as potential growth.
In this example, the opportunity cost comes to $48,424. Put another way, if you didn’t have to pay any fees at all, you would have an additional $48,424 in wealth.
So your total cost when these are added together for investing in these funds comes to $86,634. That is a serious amount of money.
This is why it matters as to how much you pay in fees.
Comparing Investments With Different Fees
Let’s now compare two different funds with different expense ratios.
Fund ABC has $50,000 invested and charges a 1.16% expense ratio. Fund XYZ also has $50,000 invested and charges a 0.33% expense ratio.
Both funds are invested for 25 years and grow at 8% annually.
At the end of the 25 years, your $50,000 investment in Fund ABC grew to $255,789 which is a nice return.
But what about Fund XYZ? At the end of 25 years, your $50,000 investment grew to $315,265.
That is a difference of over $59,476 compared to Fund ABC!
The higher investment fees you paid ate away at your money.
When we break things down further, the fees you paid in Fund ABC totaled $38,210 over those 25 years while in Fund XYZ they totaled $12,369.
The other $33,634 is from opportunity cost.
The point is, by just investing in funds that have a lower operating cost, you keep more of your money and this results in your money working more for you.
What Can You Do About It?
The good news is that investing in low fee investments is 100% in your control.
You choose what investments you invest in and the mutual funds and exchange traded funds tell you how much they charge.
Because of this, there is no reason to invest in high fee funds.
There is no correlation that funds charging higher management fees return more than funds that charge a lower management fee.
In fact, most actively managed mutual funds do not beat the market on a regular basis.
So by investing in index funds, which charge bare bones expense fees, you are earning a good return and keeping more of your money.
For example, the iShares S&P 500 ETF (IVV) has an expense ratio of 0.04%.
If you invest $50,000 for 25 years in this ETF, you end up paying $1,569 in management fees and lose $1,839 in opportunity cost.
The ending value of your investment is $339,016.
Compare that to the Vanguard Star Fund example earlier (expense ratio of 0.31%), and the value of your investment with the iShares ETF is worth $22,166 more.
As a general guide, when it comes to mutual funds, you should not be paying more than 0.50% in management fees for domestic stock funds.
For international funds, you should not pay more than 1.00% in management fees and for bond funds, you should stay under 0.30% in management fees.
For exchange traded funds, you can easily be below 0.30% for everything you invest in, and as a result, ETFs are a superior investment choice.
You work hard for your money.
Take the time to understand how much your investments are costing you.
While you cannot invest in mutual funds or exchange traded funds for free, you can invest in good, low cost funds and keep more of your money.
Don’t be blind to how much of your money investment fees are costing you. Be a smarter investor and end up with more wealth as a result.
Author Bio: Jon Dulin is a personal finance expert helping people improve their finances for over 15 years. You can read more of his work at MoneySmartGuides.com where he helps readers pay off debt and start building wealth so they can achieve their dreams.
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